Opinion of the Day: Modern Portfolio Theory Is Junk Science

Modern Portfolio Theory

Modern portfolio theory (MPT) is a theory of finance that attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets.

So why am I calling it junk science?

For example, to the extent prices in the stock market move differently from prices in the bond market, a collection of both types of assets can in theory face lower overall risk than either individually.

While it is true that stocks and bonds often move differently over shorter time frames, stocks and long-term bonds have been moving together since the early 1980s. Rates fell. Both bond prices and stock prices went up. For long-term investors, only the long-term should matter. Anyone who thinks that stocks will do okay if the widely assumed "bond bubble" pops needs to have their head examined. Junk science.

MPT also assumes that investors are rational and markets are efficient.

Hilarious! Junk science.

The framework of MPT makes many assumptions about investors and markets.

Many assumptions? Junk science.

During times of financial crisis all assets tend to become positively correlated, because they all move (down) together. In other words, MPT breaks down precisely when investors are most in need of protection from risk.

Theory prone to failure? Junk science.

The risk, return, and correlation measures used by MPT are based on expected values, which means that they are mathematical statements about the future...

Using the distant past to predict the distant future? Junk science.

Essentially, the mathematics of MPT view the markets as a collection of dice. By examining past market data we can develop hypotheses about how the dice are weighted, but this isn't helpful if the markets are actually dependent upon a much bigger and more complicated chaotic system—the world.

Basing investment decisions on a collection of dice? Junk science.

Following MPT means portfolio managers can invest in assets without analyzing their fundamentals...

Using a gambling strategy instead of fundamentals? Junk science.

I'm saving the best reason for last. In 1966, Alan Greenspan stated:

The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

I am a believer. If you are a believer as well, then surely you must realize that modern portfolio theory offers a false sense of security. The herd cannot possibly protect itself by all doing the same thing at the same time. That's a pretty darned big target for the welfare state.

For the Love of All That's Holy, Please Buy 100 Pounds of Coal on April Fool's Day!

March 31, 2015
Appalachia Miners Wiped Out by Coal Glut They Can't Reverse

Companies will dig up at least 17 million tons more coal than power plants need this year, Morgan Stanley estimates.

We can temporarily solve this problem together if every man, woman, and child in the USA buys one hundred pounds of coal tomorrow! That's what the math says. And then, next year, we can do it again! Woohoo!

And if that doesn't work, perhaps we can convince Yellen to lower interest rates to create some more coal price inflation? Zero percent interest rates? Is she nuts? Seems way too high!

Uh, oh. Just got a call from my attorney. Seems I have exceeded the legal limit for quarterly sarcasm. Damn! Should have waited until tomorrow to post this. Live and learn.

Checking Out That Rising Interest Rate Environment (Musical Tribute)

The following chart shows total checkable deposits.


Click to enlarge.

Based on the chart, which is the better question:

1. When will banks need to raise interest rates to attract checking deposits?

2. When will banks require you to give them a toaster if you wish to open a new checking account?

Those anxiously awaiting higher interest rates on their checking accounts may be sorely disappointed. Mine pays 0.04%. I am earning roughly 3 cents per month per thousand dollars. I try not to spend it all in the same place, but I admit that it does tend to burn a hole in my pocket.



Source Data:
St. Louis Fed: Total Checkable Deposits

The Crock of @#$% Report v.003

March 30, 2015
7 Utilities Stocks With High Dividends That You Should Buy Now

NEW YORK ( TheStreet) -- Looking for a safe stock to put your money in that also can generate income?

Absolutely!

Utilities stocks are generally considered safer investments, especially in times of market volatility.

Fantastic!

The debt-to-equity ratio is very high at 2.13 and currently higher than the industry average, implying increased risk associated with the management of debt levels within the company. Along with this, the company manages to maintain a quick ratio of 0.48, which clearly demonstrates the inability to cover short-term cash needs.

I know that you said I should buy all seven of these stocks, you know, for the safety. Is there something bad that will happen if I opt to pass?

Quote of the Day

March 30, 2015
Why are interest rates so low? - Ben Bernanke

Interest rates around the world, both short-term and long-term, are exceptionally low these days.

Is that the quote of the day? No. You'd have to just now be coming out of a decade long coma to think that is it.

Low interest rates are not a short-term aberration, but part of a long-term trend.

Getting warmer! But it is still not the quote of the day. High standards must be met.

The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns.

Bingo! That's the quote of the day! Well done Ben Bernanke. Had no idea you had it in you!! When it comes to real interest rates, the Fed is impotent compared to the state of the economy!!

It would therefore stand to reason that if the sustainable level of real returns was falling over the long-term, then the state of the economy must be deteriorating over the long-term. Right?

August 15, 2013
The Long-Term Death of Real Yields


Click to enlarge.

Have I mentioned lately that it is getting harder and harder to make money off of money?

When there is a glut of anything, it is difficult to make money off of it. It should therefore not surprise us that it is difficult to make money off of a money glut.

Immortal Investor Idiot Only Earned 8.7% Annual Return!

March 27, 2015
First U.S. penny sold for $1.2 million

The first U.S. penny is 223 years old, and is also worth a lot more than one cent.

That's only an 8.7% average annual return.

($1,200,000 / $0.01)^(1 / 223) = 1.087

What a f#%^ing idiot! As we all know, the stock market generates 10% returns for all eternity. Always has, always will. Should have made $17 million off that penny!

$0.01 x 1.1^223 = $17.0 million

Don't make the same mistake. Invest your penny in the stock market today and lock in your guaranteed path to long-term prosperity!*

* Past performance not necessarily indicative of future results. Your penny's performance may vary. Risk of substantial loss. Contact your financial penny advisor for penny wealth management ideas and options.

In all seriousness, ever get the feeling that some things are just too good to be true? Over an eternity, that's how I feel about 10% stock market returns. Go figure.

This is not investment advice.

Advice for Retirees

1. Crystal Meth. Although I have never tried it nor have any desire to try it, some people seem to love it. I've heard that it can mess you up for life, but let's face reality here. As a retiree, there probably isn't all that much life left to get messed up. No better time than the present to take a few risks.

2. Downsizing. Many advisors might suggest that moving to a smaller house will save you money. While true, there's absolutely no need to do this. Instead, find a house of roughly the same size in a much higher crime area. Think of the money you'll save on property taxes and upkeep! A fully neglected house will deteriorate at a slower pace from here. Look for one of those! As an added bonus, you'll be located much closer to the crystal meth. That will save on transportation costs.

3. Fire insurance. Drop it. If you are like me, you've never seen your house burn. Only the houses of others burn (especially those manufacturing crystal meth). So why pay insurance for an event that probably won't happen? Take a few risks I say.

4. Dream vacation. Use the money saved so far to live a little. Take that dream vacation to Vegas you've always wanted. Don't worry about your house while you are gone. Just ask your local meth dealer to keep an eye on it. He's just out there standing around anyway. I'm sure he'd appreciate a few extra dollars of tip income. Hey, maybe you can even cut him and his buddies in on some of your winnings when you get back.

5. Margin debt. It can really enhance your returns in retirement. You'd be foolish not to do it. I mean really, you've already started taking crystal meth, moved to a high crime area, dropped the fire insurance, and are taking dream vacations in Vegas. Why stop the risk taking now? I am not alone in my thinking.

March 27, 2015
Forbes: Should Retirees Seeking Income Go Into Debt?

What’s controversial is Anderson’s notion that the couple should not strive to pay off that mortgage. He’d be happy to see them leave behind an unpaid balance (and appreciated real estate) to their heirs. Still more contentious is his suggestion that they should finance their retirement in part by running up margin debt on their stocks and bonds.

This is not investment advice. It is actually heavy sarcasm. I know that sometimes it is difficult to tell the difference.

In-Sure Things!

Everyone always needs proper protection in this uncertain world! Now that interest rates are so low, insuring things is a sure thing! Common knowledge! Can't lose!

March 27, 2015
Analysts Say Low Interest Rates to Drag on Insurer Profits, Dividends Long-Term

Credit rating agency Moody’s said it expected interest rates to remain at a low level, cutting the return that insurers earn from investing in new bonds as they replace their stock of maturing, higher-yielding debt.

Fortunately, this is no doubt already priced into Jeremy Siegel's wise and all-knowing forward looking stock market (using several hundred years of backward looking historical returns and extrapolating them into the distant future).

And since it is fully priced in, what's the worst that could happen?

Investors have been piling into insurance stocks on the expectation of higher dividends and share buybacks from insurers that are not able to put that cash to work in the business, where premiums are pressured by stiff competition.

If you wish to sleep well at night, I will hope for your sake that you do not have a vivid and/or active imagination. Further, being color blind when it comes to seething red might also help.

Oh, man. Did I just say seething red? Freudian slip. I meant seeing red! You know, like "needing" big fat investment returns in the black and then finding out there aren't any. The seething actually comes moments later. Sorry about that.